Are REITs Considered Fixed Income?

Posted by Robert Cobean on Mar 23, 2022

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To explore whether Real Estate Investment Trusts (REITs) are fixed income investments, it will be helpful first to examine what a REIT is and what a fixed income investment includes.

What Is a Real Estate Investment Trust?

A REIT is a company that owns, operates, or finances real estate assets. REITs obtain capital from a group of investors and function similarly to a mutual fund, offering the participants fractional ownership of the portfolio's properties. REITs can own any commercial property as long as it seeks to generate income. REITs can also own financial obligations like mortgages instead of or in addition to property.

However, to maintain its status as a REIT, the company must follow some rules, including these:

  • Invest at least 75% of its total assets in real estate or related financial instruments.
  • At least 75% of gross income must come from rents, mortgage interest, or real estate sales.
  • The REIT must distribute at least 90% of taxable income to shareholders.
  • A board of directors or trustees must manage it.
  • The REIT must have at least 100 shareholders after one year of existence.
  • The ownership concentration must be limited.


What Is a Fixed Income Investment?

Fixed income investments are financial instruments that typically offer consistent returns on the invested principal. Often, a fixed-income investment is a bond, a certificate of deposit, or a money market fund. Investors may choose fixed income over other options in pursuit of reliable cash flow, even if it offers a lower return than other choices (like stocks). Fixed income investments are not necessarily guaranteed but may be more reliable than other choices.

Some investors choose fixed income instruments as part of their portfolios to stabilize their capital preservation while generating income. Some options, like municipal bonds, can also offer tax-exempt income. Still, fixed-income investments are subject to risks from inflation, interest rates, and other economic forces.


REITs Have Risks but Seek to Offer Income

Since REITs return most of their income (at least 90%, as noted above) to the shareholders, they do not pay federal income tax. Instead, the shareholders pay taxes on the dividends they receive from the investment. Much of the income is in ordinary dividends and taxed at the regular income rate. If the REIT divests property at a profit, the shareholders receive a share of the gain and are potentially taxed on that capital gain. Currently, due to the Tax Cuts and Jobs Act, REIT dividends may be eligible for a 20 percent pass-through deduction.


Income is Not Guaranteed

REITs have risks, like every investment. Many are publicly traded, which may offer liquidity that isn’t present with some other real estate investments but can increase the risk of volatility. Some REITs have high transaction and management fees, so investors must examine the details of the fund in which they decide to invest. While not providing fixed income, REITs may offer access to fractional ownership of commercial real estate investments and potential passive income streams.

 

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. There is no guarantee that companies that can issue dividends will declare, continue to pay, or increase dividends. A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate. There are risks associated with these types of investments and include but are not limited to the following: Typically no secondary market exists for the security listed above. Potential difficulty discerning between routine interest payments and principal repayment. Redemption price of a REIT may be worth more or less than the original price paid. Value of the shares in the trust will fluctuate with the portfolio of underlying real estate. There is no guarantee you will receive any income. Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes. This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus.

 


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